Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

RETAILING

NEW$ & VIEW$ (10 August 2016): NFIB; Productivity Uncertainty

U.S. Small Business Optimism Strengthens

The National Federation of Independent Business reported that its Small Business Optimism Index increased 0.1% during July to 94.6 following an unrevised 0.7% June rise. Despite the gain, optimism remained down 1.1% versus last July.

nfib-optimism-graph

An improved -5% of firms were expecting the economy to improve, the best reading in twelve months. A lessened 1% were expecting higher real sales in six months. A reduced 25% were planning to raise capital expenditures. A steady eight percent reported that now was a good time to expand the business, but that was down from 15% in December 2014.

Employment prospects were mixed. Twelve percent of firms expected to increase employment, up slightly m/m. A lessened 46% of respondents found few or no qualified candidates to fill job openings while a reduced 26% of firms had positions they were not able to fill right now, equaling the most of the economic expansion. Twenty-four percent of firms raised worker compensation over the last three months, steady with the first half, while 15% were expecting to raise it in the next three months, steady with Q1.

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From the survey:

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…results in that:image

U.S. Wholesale Inventories Increase; Sales Strengthen
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U.S. Productivity Fell for Third Straight Quarter The longest slide in worker productivity since the late 1970s is haunting the U.S. economy’s long-term prospects, a force that could prompt Fed officials to keep interest rates low for years.

Nonfarm business productivity—the goods and services produced each hour by American workers—decreased at a 0.5% seasonally adjusted annual rate in the second quarter as hours worked increased faster than output, the Labor Department said Tuesday.

It was the third consecutive quarter of falling productivity, the longest streak since 1979. Productivity in the second quarter was down 0.4% from a year earlier, the first annual decline in three years. That was a further step down from already tepid average annual productivity growth of 1.3% in 2007 through 2015, itself just half the pace seen in 2000 through 2007, and the trend shows little sign of reversing. (…)

The economy’s potential future growth will be slower than previously expected unless productivity recovers, and their economic projections suggest Fed officials “see current policy as less accommodative, the labor market as less tight and inflationary pressures as more limited,” former Fed Chairman Ben Bernanke said Monday on his blog.

The policy implications, Mr. Bernanke said, “are generally dovish, helping to explain the downward shifts in recent years in the Fed’s anticipated trajectory of rates.” (…)

Fed Chairwoman Janet Yellen in June described the outlook for productivity growth as a “key uncertainty for the U.S. economy” and a “very difficult question” that has divided the economics profession.

“Some are relatively optimistic, pointing to the continuing pace of innovations that promise revolutionary technologies, from genetically tailored medical therapies to self-driving cars,” she said. “Others believe that the low-hanging fruit of innovation largely has been picked and that there is simply less scope for further gains.”

Ms. Yellen described herself as “cautiously optimistic” but said it “would be helpful to adopt public policies designed to boost productivity,” such as promoting investment. (…)

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Another uncertainty for Mrs. Yellen. As an economist, she is right. More investment would likely boost productivity. Business people look at this other chart and ask why they should be investing any more in physical capacity? That is the last thing they need. What they need is revenues. More on this in CETERIS NON PARIBUS.

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BTW, this is not just an American phenomenon as RBC Capital illustrates:

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Meanwhile, unit labor costs are creeping up: +1.7% YoY in manufacturing and +2.1% in total in Q2 (charts from Haver Analytics)

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In recovering housing market, the starter home remains elusive

(…) Nationwide, the inventory of homes costing $250,000 or less fell more than 12 percent between June 2015 and June 2016, according to the National Association of Realtors.

The shortage stems from higher labor, land and building permit costs that have caused construction companies to focus on higher-end homes that bring more profit. In addition, institutional investors are snapping up affordable homes by the thousands in select markets nationwide and converting them to rentals.

For a graphic showing the declining number of starter homes for sale in key markets, see:tmsnrt.rs/2aZWkJ8 (…)

Over the past four years, the number of entry-level homes for sale – defined as those priced in the lower third of a local market – has fallen by 34 percent, according to a Reuters analysis of data compiled by listings firm Trulia. (…)

Corporations or companies now own nearly one fifth of all homes priced under $300,000 that are not occupied by their owners, according to property data firm ATTOM Data Solutions, though investor purchases have slowed since peaking in 2013. (…)

Young adults aged 18 to 34 earn $2,000 less per year today than they did in 1980, after adjusting for inflation, according to the Census Bureau, and they have amassed record levels of student debt.

Outstanding student loan debt totaled $1.2 trillion in the fourth quarter of 2015 – trailing only mortgage debt among all consumer debt categories, according to the New York Fed. The average student loan monthly payment has jumped 50 percent in constant dollars, to $351, over the last 10 years. (…)

Average residential land values are up about 79 percent over the last four years, to a level last seen when the housing market peaked in 2007 and 2008, according to the Lincoln Institute for Land Policy.

The cost of building a new home, including permit fees, labor and materials, meanwhile, has jumped to 61.8 percent of the cost of an average single-family home, compared with 48.1 percent in 2007. (…)

U.K. Retail Sales Defy Brexit Vote Rise in July sales counters earlier surveys signaling a slowdown in consumer activity

(…) The British Retail Consortium said Tuesday that like-for-like sales—stripping out stores that have opened or closed—rose 1.1% in the four-week period from July 3 to July 30, compared with the same period a year earlier. In July 2015, sales increased 1.2%. The July sales rebounded from a fall in June, when like-for-like sales dropped 0.5%.

The BRC, which conducted the survey with accountancy firm KMPG, said sales were boosted by promotional activity and warm weather. Sales for all stores rose 1.9% compared with a 2.2% gain in July 2015 and a 0.2% increase in June. (…)

In its own survey of consumer spending Tuesday, analysts at Barclays had a cloudier view. It found spending rose 2.6% year-on-year in July, a softer rate than the 3.6% in June and May. The bank’s so-called underlying spending growth index—which targets categories less affected by weather, the timing of holidays and geopolitical events—fell 5.3% in July, its lowest level since June 2014.

Barclays measures spending on U.K.-issued Barclaycard credit and debit cards, which include retail sales but also other purchases like travel and entertainment, both at home and abroad. (…)

UK government bonds turn negative in historic rally Gilt prices surge on Bank of England pledge over asset purchases
French Tourism Tumbles 10% On Average Following Terrorist Attacks
Saudi Oil Output Sets Record Despite Global Glut OPEC says the kingdom’s July output rose to nearly 11 million barrels as it focused on market share over prices, which are in the midst of a two-year slump.

Top oil exporter Saudi Arabia told OPEC that its July crude production hit a record of 10.67 million barrels as it meets seasonally higher domestic demand and focuses on maintaining market share rather than trimming supply to boost prices.

According to figures submitted by the kingdom to the Organization of the Petroleum Exporting Countries, its previous production high was 10.56 million barrels a day in June 2015.

The group’s kingpin saw its production rise in July by 30,100 barrels a day to 10.48 million barrels a day, based on OPEC’s secondary sources such as shippers, analysts and industry executives. The figures were released in the OPEC’s monthly report Wednesday. (…)

OPEC, which controls more than a third of the world’s oil supply, said its July crude production inched up 46,000 barrels a day to 33.11 million barrels a day on higher output from Iraq and Saudi Arabia. The cartel now has 14 members since Gabon was added in June.

The organization said in its report that it raised oil demand growth in 2016 to 1.22 million barrels a day, some 30,000 barrels a day higher than last month. For 2017, world oil demand is forecast to grow by 1.15 million barrels a day, unchanged from last month’s report. (…)

Non-OPEC oil supply is expected to contract by 79,000 barrels a day this year, an upward revision of 90,000 barrels a day on higher-than-expected output in the second quarter from the U.S. and U.K. In 2017, non-OPEC supply is expected to decline by 150,000 barrels a day, following a downward revision of 40,000 barrels from last month.

OPEC said demand for its crude this year is still expected to reach 31.9 million barrels a day. For 2017, Demand for OPEC crude is forecast at 33 million barrels a day.

SENTIMENT WATCH

A rather compelling indicator that should make equity investors cautious is in the next chart. It shows speculative accounts’ net VIX exposure. Shorting VIX has become a massive (and very profitable) carry trade, indicating heightened risk appetite. (The Daily Shot)

CETERIS NON PARIBUS

(…) The Iiwa — or intelligent industrial work assistant — is produced by Kuka, one of Germany’s most innovative engineering companies. But it will not be entirely German for long. Less than a month after the fair, a Chinese appliance-maker called Midea offered to buy Kuka for €4.5bn, in the largest ever Chinese takeover of a German company. (…)

(…) Transactions with a total value of $10.8bn were announced in the first half of this year, according to EY, the professional services firm — more than all previous years combined. Chinese investors acquired 37 German companies in that period, EY says — compared with 39 in the whole of 2015. (…)

The range of targets has been wide. Last month, Osram, one of the most venerable names in German business, sold its lamp unit to a consortium led by Chinese LED specialist MLS for more than €400m. In February, Beijing Enterprises bought EEW, the German waste management company, for €1.44bn. Also this year, ChemChinaagreed a €925m deal to buy German machinery maker KraussMaffei Group. (…)

German technology firms are a key focus, but the Chinese net has widened to include everything from pharma and biotech companies to clinics and care homes. (…)

BTW: remember this?

Renminbi shock a distant memory for currency markets

UNINTENDED CONSEQUENCES

UK corporate pensions’ deficit continues to rise as interest rates collapse. (The Daily Shot)

With the above as the backdrop, something unusual happened. The Bank of England’s QE ran into trouble trying to purchase bonds because institutional investors (including corporate pensions and insurance firms) have nothing to replace these securities with – even if they make a significant profit. These organizations need a yield that covers their liabilities and cash is not going to get them there.

Source: @FT

NEW$ & VIEW$ (4 August 2016)

Heavy-Duty Truck Order Slump Deepens

An unusually high number of cancellations in orders of heavy-duty trucks caused net orders in North America to plummet to the lowest point in over six years, according to a new report by research firm FTR.

Trucking companies in July ordered 10,400 Class 8 trucks, used for long-haul routes, below expectations and 56% fewer than the same period last year, according to preliminary numbers from research firm FTR released Wednesday. It was the fewest number of orders since February of 2010.

Heavy-duty truck orders, which have been sliding for months, were hit with “several significant order cancellations,” which is uncharacteristic for this time of year, FTR said in its report. “The high cancellations are likely the result of fleets placing large orders at the end of 2015, for delivery a year out,” said Don Ake, vice president of commercial vehicles at FTR in the report. (…)

There are “too many trucks chasing too little freight,” said Steve Tam, vice president at ACT Research, which also tracks heavy-duty truck sales. Truck orders are low now asfleets adjust their overly optimistic expansion plans after seeing strong growth in 2014and early last year, he said. ACT reported 10,500 Class 8 orders for July.

“I think the trucking community had an expectation that [growth] was going to continue. But with 20/20 hindsight, that did not happen. Freight has been very flat for basically the last year,” he said. “There are anecdotal signs that freight is improving very modestly, but I would liken it to treading water but still below surface at this point.”

Here are the charts from Zerohedge:

Eurozone retail sales fall flat in June

Sales growth was 0 per cent in the single currency area – falling short of a small expected rise – and fell 0.2 per cent in the wider EU.

On a yearly basis, retails sales rose 1.6 per cent in June and were up 2.4 per cent across the 28-member bloc.

The FT was the only mainstream media to report this important data but this is all it gave its paying readers.

Here’s what my non-paying readers get:

Pointing up Q2 sales volume rose 0.6% (+2.4% a.r.) after a flat Q1. Ex-food, ex-gas, real sales rose 0.3% in June when gas sales dropped 1.3%. “Core” sales are thus up 4.0% annualized in Q2 after a flat Q1. And this is in spite of a pretty weak June in the U.K. (Data from Eurostat)

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  • And this from Markit on trends in July:

imageLatest Markit Eurozone Retail PMI® survey data showed the continuation of contrasting trends in sales performance across the bloc’s big-three retail sectors, with a further sharp drop in sales in Italy offsetting steady growth across Germany and France.

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About the U.K. (via The Daily Shot):

Bank of England Cuts Rates, Orders New Round of Money Printing
China’s Central Bank Plans to Keep Policy ‘Prudent’
OIL
Analysts Turn Bearish on Oil Again Investment banks have cut their outlook for oil prices for the first time in four months, concerned about the continued oversupply in crude that has already sunk this year’s market rally, according to a Wall Street Journal survey.

A survey of 13 investment banks by The Wall Street Journal predicts that Brent crude, the international oil-price benchmark, will average $56 a barrel next year, down by more than a dollar from June’s survey. The banks expect West Texas Intermediate, the U.S. oil gauge, to average $55 a barrel next year, down almost a dollar from the previous survey. (…)

The banks in the survey see oil prices staying below $50 a barrel until the end of this year and rising to $60 a barrel by the end of next year. Last summer, many of the same banks were predicting oil prices would rise to more than $70 a barrel this year. (…)

  • What Oil in the $40s Means for Oil Majors For how long can Europe’s big-five energy companies maintain dividend levels? Second-quarter results disappointed and the oil price fell about 20% in the past two months.

(…) The five big European groups, BP, Shell, Total SA, Eni SpA and Statoil ASA, began the year on consensus forecasts of $7 billion in total free cash flows for the next four quarters, according to Morgan Stanley analysts. By the end of June, that rolling four-quarter forecast had leapt to $25 billion.

That is far away from how the five companies have been performing. Free cash flows actually have been worsening and recent results took cumulative flows for the past four quarters at the big five down to minus $23 billion, according to Morgan Stanley.

Companies with negative free cash flow can support dividends with higher debt for a while if they think rising commodity prices are going to bail them out, but not forever. (…)

Despite second-quarter hiccups, analysts are still forecasting a big recovery in cash flows and profits in 2017 and beyond. But these depend on a pickup in oil prices: at UBS for example, forecasts are based on oil at $60 a barrel on average next year, $70 in 2018 and $75 thereafter.

And companies are working to lower breakevens, with BP aiming for a business that works at $50 to $55 a barrel. Brent crude has been below that level for most of the past year.

Nevertheless, payout promises will need to be revised if stuttering global growth and oil back in $40s is a taste of more disappointments to come.

Same in U.S. and Canada…

From the FT’s Lex column:

(…) The price crash last summer brutalised the US shale sector. According to law firm Haynes and Boone, 85 North American producers have filed for bankruptcy since early 2015. However, amid the wreckage, drillers have taken defensive action. Research firm Wood Mackenzie notes that of the $250bn of global E&P capital expenditure cuts in 2016 and 2017, two-thirds has come from US independent producers. It reckons that 56 US producers can now break even at $50/barrel.

The ultimate question for a recovery in prices is how output responds. Even though rig counts are down nearly 80 per cent since 2014, efforts to enhance well productivity have kept production resilient. From its April 2015 peak of 9.7m barrels per day, production is off less than a tenth. And for companies with efficient operations in low-cost regions, there is temptation to grow. Pioneer Natural Resources, focused on the desirable Permian Basin in Texas, said it would boost its oil production by a quarter in 2016, reasoning that even if prices are wobbly, incremental barrels remain profitable. Its investors are happy with the plan: it raised $2bn in new equity in March and its shares are up a quarter over the past year.

Pioneer and other marginal firms can survive, and even expand a bit, with a depressed oil price. But over time the decline in investment, productivity gains aside, is curtailing future output growth. Wood Mackenzie says that resultant production losses will be 4m barrels a day by 2020. Prices may have to snap back. A happy ending for those who have managed to survive to the end of the movie.

Pointing up By the way, here is the spread between Saudi and US oil production. It’s moving in the direction the Saudis want. (The Daily Shot):

SENTIMENT WATCH
Goldman Finds The Treasury Market No Longer Reacts To Economic Data

(…) Goldman’s Elad Pashtan writes, “the sensitivity of US Treasury yields to economic data surprises has declined to near record-lows over the last two years. We find that the pattern of reactions to data surprises across the yield curve matches pre-crisis norms—with higher sensitivity for short-term rates than longer-term rates—but the average reactions are much lower; for breakeven inflation reactions to growth data are not discernible from zero.”

So if it is not the economy, then what does the “market” respond to?  Take a wild guess:

In contrast, Treasury yields have reacted more strongly to Fed communication, at least according to one measure of policy surprises, and the sensitivity of exchange rates to activity news has increased. (…)

One possible explanation for this phenomenon is that investors are now more focused on Fed communications, rather than to economic data releases—perhaps due to uncertainty about the central bank’s reaction function. And we do see some evidence along these lines. (…)

Add this to the list of strange things happening at this stage of the cycle:

BTW: Turkey’s inflation jumped on higher food prices and weaker lira (after the coup). More inflation to come? (The Daily Shot):

Beware of Customized ‘Earnings Before Bad Stuff’ Companies that report significantly stronger earnings by using tailored figures like ‘adjusted net income’ or ‘adjusted operating income’ are more likely to encounter some kinds of accounting problems than those that stick to standard measures, according to new research.

(…) The study focused on companies in the S&P 1500 index. It found that just 3.8% of those exclusively using standard GAAP metrics had formal earnings restatements from 2011 to 2015. Among heavy users of non-GAAP measures—those whose non-GAAP earnings were at least twice as high as their GAAP net income—the rate was 6.5%.

Similarly, 7.5% of the GAAP-only group had material weaknesses in internal controls—flaws in their procedures to prevent financial errors and fraud—versus 11% of the non-GAAP group.

(…) the results suggest companies using non-GAAP metrics heavily “may be somewhat less rigorous in other accounting areas” than companies using only GAAP, said Robert Pozen, a senior lecturer at the MIT Sloan School of Management. (…)

Even critics acknowledge the tailored metrics can sometimes be helpful—showing a company’s results in constant currency is a legitimate adjustment, for instance, Mr. Pozen said.

But there is also a concern they are being abused, that companies are stripping out normal, ongoing costs to make themselves look healthier. (…)

  • Alliance Bernstein adds this (via ValueWalk)

(…) In 2015, about 87% of companies in the S&P 500 reported adjusted earnings, up from 73% in 2010. And the median size of the adjustment increased from 8% in 2010 to 25% in 2015. In aggregate, reported GAAP earnings were almost 22% below adjusted earnings last year. Overall, there has been a sizeable increase in both the frequency and the magnitude of the adjustments. (…)

Although earnings adjustments in 2015 were higher than the 10-year average in six out of ten sectors studied, the bulk of the increase was driven by energy and healthcare (Display). Energy companies have been writing down investments made when oil prices were a lot higher than they are now. In healthcare, a spate of deals and consolidation among the largest companies has led to steady growth in amortization of intangible assets, generally excluded from adjusted earnings. (…)

GAAP Earnings, GAAP Accounting

While the causes of the write-offs in these two sectors may seem different on the surface, they share a common root. In each case, managements were striving to grow earnings in a low-growth world—and, to put it bluntly, they overreached. Energy companies paid too much for drilling rights and development crews, banking on the idea that oil prices would remain at their historical highs or rise even higher. In the case of healthcare, high valuations for target acquisitions drove companies to make overly optimistic projections about their ability to raise prices, expand distribution and commercialize drug pipelines.